Wages, profits, inequality: wage-price spirals revisited

Abstract In times of inflation, the fear of so-called wage-price spirals becomes a central motif for policymaking. Yet, empirical studies on this phenomenon of spiraling input costs remain scarce. Lacking altogether is an assessment of the distributional effects of this form of cost-push inflation. Drawing on a standard sector-level cost-push inflation model, we examine the potential first- and second-round effects of a wage-price and wage-price-profit spiral scenario following the 2021 energy price spike as well as their distributional implications across 14 countries of the European Union. Our main results are threefold: first, we observe relatively small second-round effects, casting substantial doubt on the empirical validity of conventional wage-price spirals. Second, if sectors succeed in defending their profit margins while workers continue to defend their real wages, the emerging wage-price-profit adjustments may substantially add to inflationary pressures. Third, for the countries under consideration, wage-induced second-round effects appear to be progressive and substantially more benign than the regressive first-round effects of the energy price increases. This raises the question of whether second-round effects are a price worth paying.